How you spend them may shape the future of your ranch.
Some ranchers make money in all but the worst of times. Others make money only in the best of times. And what's the best way to reinvest profits to assure long-term profitability and survival?
That's the question we posed to a cross section of ranchers and ranch economists.
"Pay all your debts," says Len Mertz, a west Texas rancher and certified public accountant. "That gives you the latitude to take advantage of an opportunity down the road."
Debt reduction also lowers the break-even point, which boosts the chance of surviving an extended economic down-turn or an extended drought.
"Any economic or environmental hardship is going to take its toll even on the strong businesses," Mertz says. "But those that are highly leveraged - they're in trouble."
Three decades ago, common business wisdom held that debt wasn't such a bad thing. In the high-inflation environment of the 1970s, business theory held that you could borrow and then pay your loans with cheaper inflationary dollars. When Reagan administration fiscal policies tamed inflation, many debt-laden businesses of all types failed.
Now, debt is widely viewed as a necessary evil, the less of it the better. And, ranchers with low debts have much more latitude when it comes to spending profits. They can use the money to expand or to increase the efficiency of an existing operation.
High-profit years don't come along very often. That gives ranchers plenty of time to figure out how to spend the money so they will get the most out of it.
"I try to set priorities," says Wyoming rancher Joel Bousman. "I usually have things in mind that need doing the worst. I try to break them down as to what kind of economic return they would provide."
The process begins by setting priorities for spending profits. If you don't set priorities, you won't get the best return from your investment in land, equipment or livestock. In the worst case, you may get no return.
For instance, if you buy a $30,000 fully-loaded supercab pickup, when the old pickup would have lasted for years, the return is next to nothing. If the $30,000 was used the pay down debt, the ranch would lower its break-even point by thousands of dollars a year.
"The bottom line is look for your best returns, whether it's increasing your income or decreasing your expenses," says David Saxowsky, associate professor of agricultural economics at North Dakota State University. "For some, it might be to take that extra income and pay long-term debt. For others, it might be to buy capital equipment.
It is possible to blow profits so you see little, if any, long-term benefit. The best rule of thumb: if it won't make money, don't invest. Here are some examples:
* Buying the latest equipment when the old equipment will last for years. Another alternative: rent the equipment that is only needed on rare occasions.
* Buying things you may not need. "Why buy a four-door pickup if a two-door is good enough?" asks Mertz.
* Spending too much on living expenses. "Don't double the size of your house when your kids are getting ready to leave home," says North Dakota's Saxowsky.
Still, there are times when it pays to be a little frivolous with ranch profits.
"If the marriage is in trouble and everybody needs a break from the pressures of keeping the ranch going, then maybe a vacation is the best use of the money," says Tull Bailey, with Texas Christian University's ranch management program.
Finally, consider investing extra money in intangibles, such as stocks, bonds, mutual funds or certificates of deposit. These investments offer a cash cushion against the next cattle price crash. One advantage of such investments is that they can be easily sold if you need money fast. Real estate can be much more difficult to unload.
Investments can also generate cash to cover estate taxes, says Bailey. Without such funds, ranch heirs may have to liquidate the operation to pay the taxes. "If I had a windfall, I might want to use 25 percent of it to pay down debt and the other 75 percent for investments," says Roy Frederick, professor of agricultural economics at the University of Nebraska.
Smart ranchers should be ready to change their investment strategy if business conditions deteriorate.
"If interest rates were to increase three or four percent, it wouldn't be very long before I would use 75 percent to pay down debt," says Frederick. "In general, it's more important to pay down debt when interest rates are high than when they are low."
In any case, economists offer a word of caution on investments outside the ranch, especially stocks or stock mutual funds. On the whole, stock prices soared in the 1990s. "As we look to the future, we shouldn't necessarily expect that to continue," says Frederick.
Another word of caution: check the tax implications if you plan to put spare cash into a retirement account and then plan to withdraw it before the normal retirement age should you need money for the ranch.
For instance, early withdrawals from a standard Individual Retirement Account that don't meet certain federal guidelines will trigger a 10% tax penalty. That 10% is on top of any other taxes owed. If you are in the 15% tax bracket, taxes plus the 10% early withdrawal penalty will wipe out 25% of your savings.
The bottom line is this: well invested profits can gradually reshape a losing ranch into a winner. And they can make a profitable ranch more profitable. The trick is to use the money where it will do the most good. The formula will differ for each ranch.
Doug McInnis is a business management writer and a contributing editor to BEEF. He's based in Casper, WY.
One of the easiest ways to show how credit erodes your finances is to examine the cost of using a credit card, which many ranchers use either for personal or ranch expenses.
If you charge $1,000 at a 12% annual rate and you only make the minimum $25 monthly payment, after one month, you've reduced your debt by $13. At that rate, it will take years to pay the balance. Meanwhile, the interest meter is ticking.
Many people never pay off cards. They use them as a revolving loan. In that case, the $1,000 balance stays and after a decade you would have paid $1,200 in interest. After four decades - the working life of many ranchers - you've paid nearly $5,000 in interest and you still owe $1,000.
"That's a bad situation to be in because all your profits are going to pay interest instead of making long-term improvements," says Wyoming rancher Joel Bousman. "You don't get any economic benefits out of paying interest." If, however, you quickly paid off the card, you would have saved $5,000 in interest that could have been used for needed equipment, better bulls or an upgraded health program.
If this scenario sounds familiar, it should. The same thing happens with the operating loans most ranchers renew each year. It also happens with land debt, loans for new trucks and other equipment. The next time you wonder where your money goes, add up your annual interest payments.